History Lesson: Buying High, Selling Low

With stocks hitting a high, everyone wants a piece of the action. Stockbrokers say clients are phoning in orders. Mutual-fund data show investors buying U.S.-stock funds, after fleeing them for years.

Buying at a high flies in the face of common sense but is often hard to resist. Ordinary investors wind up buying at elevated prices and get caught when the market eventually turns downward. Then they get frightened and sell. No wonder so many of them have trouble matching the market's gains.

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But this time there is a wild card: the Federal Reserve.

The Fed has gone out of its way to boost the economy through massive injections of cheap money into financial markets. Fed Chairman
Ben Bernanke
has made it clear, most recently in congressional testimony, that he is determined to do what it takes to keep financial markets stable and the economy growing, as long as inflation remains quiet.

The question is whether Mr. Bernanke can buck the historical trend. Bull markets tend to be getting long in the tooth by the time they hit record territory. There have been exceptions, but lately the average bull market has run out of steam less than two years after hitting its first record.

A bull market is commonly defined as a gain of 20% or more from a low. A bull market ends when stocks decline 20% or more from a high. The current bull market began in March 2009.

The Dow Jones Industrial Average usually has recorded additional gains after it hit record territory—a median of 28%, according to Ned Davis Research. If the current bull market matched that, the Dow would pass 18000 before topping out, up from 14253.77 on Tuesday.

Stock Traders Celebrate Over the Years

Fresh milestones for the Dow Jones Industrial Average are always cause for celebration among stock traders. Take a look back at shots from the floor of the New York Stock exchange from past jumps for the blue-chip index. Spencer Platt/Getty Images

In the 1990s boom, the bull market lasted nearly nine years after its first record. The current period, of course, doesn't seem comparable to that euphoric time. After a high was hit in 1972, the bull market lasted only two months. The last bull market, which ended in October 2007, continued for a year after its first Dow record, rising 21% in that period.

In all but one of the past six bull markets, purchases of stock mutual funds picked up right after the Dow's first new high, according to
Ned Davis.
In the six months after that first record, the median flow of money into stock funds, in percentage terms, was three times as strong as in the six months before.

Whether it proves wise to jump into stocks now is going to depend partly on Mr. Bernanke.

More than any other time in history, this bull market owes its strength to the Fed. Mr. Bernanke, formerly a professor at Princeton University who was first appointed Fed chairman by President
George W. Bush
in 2006, may be the world's leading academic expert on the Fed's mistakes of the 1930s, when it stopped fighting the Depression too soon.

Mr. Bernanke has repeatedly made it clear that he doesn't intend to repeat those mistakes, even though some regional Fed bank presidents and many Republicans in Congress complain his policies could create economic trouble down the road. In many analysts' view, the Fed is the bull market's strongest pillar.

Plenty of problems remain that could counteract the Fed support. Those include Europe's continuing financial uncertainty, China's uncertain economic growth and the risk that Washington's spending cuts could harm the U.S. economy. Terrorism concerns and Middle East tensions also lurk.

There is also the chance investors won't pile in this time. In 1972, after the Dow hit a record, skittish mutual-fund investors kept taking money out of stock funds. The 1970s saw repeated economic trouble that created deep skepticism about stocks, not unlike today.

ENLARGE

Traders work on the floor of The New York Stock Exchange on Tuesday.
Getty Images

If individuals stop plowing money into stocks now, it wouldn't necessarily end the bull market. The stock market has been dominated for years by hedge funds and high-frequency traders, not individuals. But it wouldn't help.

This leaves investors with two big facts. First, the bull market is old and, in a normal world, might not be far from topping out. Second, with the Fed so active, this isn't a normal world. Until the Fed shows signs of retreat, it will take a serious shock from somewhere else to send U.S. stocks lower.

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